What is gross margin and how is it calculated?

What is gross margin and how is it calculated?

• A. Gross margin percent = (COGS / Revenue)
• B. Gross margin percent = (Revenue - COGS) / Revenue
• C. Gross margin percent = (Revenue - Operating expenses) / Revenue
• D. Gross margin percent = (Profit / Revenue)

Answer: (B)

Gross margin measures how much revenue is left after covering the direct costs to produce the goods sold. It reflects the amount available to cover other expenses and profit. The proper way to express it as a percentage is to take revenue minus cost of goods sold, then divide by revenue: gross margin percentage = (Revenue − COGS) / Revenue. COGS includes the direct materials, direct labor, and allocated manufacturing overhead tied to producing the goods, but it doesn’t include selling or administrative costs. For example, if a company has $200,000 in revenue and $120,000 in COGS, the gross margin is $80,000, which is 40% of revenue. Why the other formulas aren’t correct for gross margin: dividing COGS by revenue yields the portion of revenue consumed by direct costs, not the margin remaining; subtracting operating expenses instead of COGS gives operating margin, which accounts for costs beyond production; and dividing net profit by revenue gives net profit margin, which includes all expenses beyond production.

Gross margin measures how much revenue is left after covering the direct costs to produce the goods sold. It reflects the amount available to cover other expenses and profit. The proper way to express it as a percentage is to take revenue minus cost of goods sold, then divide by revenue: gross margin percentage = (Revenue − COGS) / Revenue. COGS includes the direct materials, direct labor, and allocated manufacturing overhead tied to producing the goods, but it doesn’t include selling or administrative costs.

For example, if a company has $200,000 in revenue and $120,000 in COGS, the gross margin is $80,000, which is 40% of revenue.

Why the other formulas aren’t correct for gross margin: dividing COGS by revenue yields the portion of revenue consumed by direct costs, not the margin remaining; subtracting operating expenses instead of COGS gives operating margin, which accounts for costs beyond production; and dividing net profit by revenue gives net profit margin, which includes all expenses beyond production.